Tel Aviv running scared

Meir Sokoler, deputy governor of Bank of Israel and governor David Klein's right hand man, resolutely reiterated on Thursday that the central bank had not plans to rush and raise interest rates. "What has happened so far does not justify changing the custom of examining the data and deciding at the end of the month," he told Hebrew-language daily Ha'aretz.

But capital market investors aren't waiting for Sokoler or his boss ¿ a wave of redemptions and withdrawals washed over Israel's safest investments yesterday as shekel-based and index-linked mutual funds absorbed NIS 1 billion in withdrawals, panicked sales by investors that sank the price of Bank of Israel's short-term debt certificates and the government's unlinked bonds.

The public's flight from government securities created a situation we haven't seen on the capital market in a long time: short-term interest, theoretically controlled by Bank of Israel, leapt 6-7%, 1.5-2.5% above the interest in Bank of Israel tenders.

But the most worrisome phenomenon was on the bond market, where medium and long-term interest rates are set. The yield on unlinked bonds leapt to 8-9%, 2-3% above its level four months ago, before Bank of Israel lowered interest rates.

There is no doubt where investors headed as they fled the shekel: there was no trade yesterday on the currency market, but dollar options saw huge demand that raised the derivative exchange rate to NIS 4.9-4.95 to the dollar.

If, until a month ago, we explained that shekel devaluation was natural in light of the interest rate reduction, the global slowdown and the tech sector crisis, if, until recently, we explained that 10-15% shekel devaluation was natural and even desirable ¿ in the past few days we have entered new territory.

Daily shekel devaluation of 1% and interest hikes on the markets to twice that of Bank of Israel say one thing very clearly: the public has lost confidence in the economic leadership. The central bank, considered the anchor of stability until a few months ago, cannot calm the markets: fear of Finance Minister Silvan Shalom¿s behavior increases daily.

In theory, there is no reason to panic. Even after a year of recession and a year and half of the Palestinian uprising, the Israeli economy is strong, Bank of Israel has large foreign currency reserves and the business sector is developed ¿ after all, we have weathered no small number of local and international crises in the past decade and survived them all.

But we are going into this particular crisis with liberalized capital markets, unrestricted foreign currency trade and open money markets. Today, any investors, any citizen, can express his opinion of the government. He can buy dollars, open an account in a foreign bank or instantaneously liquidate all his investments in Israel and transfer them abroad.

This is the reason that for the first time in many years we are again walking a tightrope. This time Bank of Israel and the treasury don't have much time or space to maneuver. If the public is not convinced quickly that the economic leadership has come to its senses and the central bank has the means and the ability to maintain price and financial stability, the economy could return to a place we thought we would never revisit.

Under normal circumstances, the collapse of a small bank like Trade Bank would not be a cause for worry. Even if the supervisor of Banks, the bank's accountants and managers all fell asleep at the wheel, it still wouldn't constitute a particularly important event ¿ Trade is a small bank that was always involved in weird affairs.

But the timing of the collapse, just when the many banks' clients are wondering about the stability of the banking system anyway, is dangerous. Not all clients can tell the difference between a twerpy little bank and a major bank, and many are wondering about the functioning of the Supervisor of Banks.

Newspaper headlines about clients waiting outside the banks closed doors, only increase the uncertain atmosphere created by publication of the disappointing, half-baked emergency economic plan cooked up by the Ministry of Finance.

Silvan Shalom has proven over the past months that he is unworthy of his office, and political speculation has increased that he is looking for the way out. But also Bank of Israel's credibility has been damaged in recent months by the weird deal with Finance Minister Silvan Shalom and Prime Minister Ariel Sharon in December 2001 and by the attempt to make the bank subordinate to a monetary council controlled by the treasury.

If the prime minister doesn't come to his senses in the next few days and throw his weight into the economic arena, he may discover a new front has opened, not in Jenin or Hebron, but in Tel Aviv, Israel's financial capital, which hasn't looked as frightened as it did this week in a long time.